Economic and Financial Market Outlook Q2 2026

Global Economy: A Fundamental Bottleneck

The Marietta Investment Team’s constructive outlook entering 2026 centered on resilient consumer spending, robust capital investment, strong corporate earnings, and accommodative monetary and fiscal policy across the world's major economies. In the first quarter, those positive elements were challenged by a powerful external force. The US-Israel war with Iran and the effective closure of the Strait of Hormuz produced a global supply shock impacting commodity markets, in particular oil, natural gas, and fertilizer. In the first quarter, the front-month futures price of Brent crude oil surged from $61 to $118 per barrel, a staggering 93% increase. This has had a direct and negative impact on global growth and the longer the disruption persists, the more severe the economic fallout becomes. This week’s cease-fire attempt shows that the US and Iran both have the desire to end the military conflict and the resumption of shipping in the region is within sight. If a resolution is reached relatively soon - a plausible outcome with the two sides appearing to agree to a framework for negotiations - much of the damage would prove temporary and the underlying economic fundamentals would reassert themselves. As a consequence of the global supply shock, we lower our global GDP expectations to approximately 2.5% for 2026, below the IMF’s pre-conflict projection of 3.1% and slower than recent years. This assumes that some military activity will continue for several weeks but will reach a negotiated halt in the second quarter. We expect to experience a subsequent rise in inflation, but its duration and magnitude will depend on the longevity of the spike in energy prices.

US Economy: Testing Resilience

The US Economy was losing momentum before the first missiles struck Iran. Fourth quarter GDP was revised down to 0.5%, a sharp deceleration from 4.4% in the third quarter. Most concerning is the labor market, where the deterioration has been underappreciated. Five of the past ten months have showed net losses in payrolls. The Bureau of Labor Statistics’ annual benchmark revision cut total job growth in the entire year of 2025 to just 181,000, a number that a healthy labor market would produce in a single month. Long-term unemployment has risen +21.5% to 1.8 million, up from 1.5 million a year ago, while the labor force participation rate has dropped from 62.5% to 61.9%. An unemployment rate of 4.3% is not overly concerning but the trajectory of hiring is troublesome and deserves close attention. To increase our optimism on the US economy for the remainder of the year, we will need to see a turnaround in the labor market. An encouraging March report of 178,000 jobs gained suggests an improvement is underway.

Despite the shaky labor market, there have been real sources of resilience throughout the US economy. Business activity surveys have remained in expansion, with datacenter construction and AI-related capital expenditures driving enormous investment. Consumer spending, while uneven across income levels, has held up in aggregate. These are not the characteristics of an economy in freefall. The question for the second quarter is how well the US economy can absorb another blow, this time in the form of high gasoline and energy prices that raise costs for businesses and households simultaneously.  

We reduce our forecast for 2026 US GDP growth to 2.0% - 2.5%, a step down from our prior expectation of 3.0%. The risk is skewed to the downside, as higher oil prices act as a tax on consumers and cost pressures will extend to shipping, agriculture, and the broader supply chain. Inflation, which has remained stubbornly above target even prior to the Iran conflict, will likely reaccelerate as energy costs filter through to prices. We expect headline inflation to climb to 3.5% or higher in the coming months. However, if the cease fire holds and a deal is struck between the US and Iran, this inflation setback will be short-lived. 

US Stock Market: A Tug of War

US equities have slumped, with the S&P 500 total return in the first quarter -4.3% and the Nasdaq falling more than 10% from peak to trough. Not surprisingly, since the announcement of a cease fire, stocks have bounced substantially higher. Markets have abruptly shifted to incorporate the reality of higher input costs. The sole beneficiary has been the energy sector, with the State Street Energy Select Sector ETF (XLE) rallying +37.9% in the first quarter. The pattern has been clear and likely to persist until something fundamentally changes: when oil rises, stocks fall. Until investors gain confidence on the resolution of the Iran conflict, we expect this negative relationship to continue driving short-term market direction, both to the upside and downside.

The fundamental case for equities has not collapsed. Corporate earnings remain the strongest pillar of the bull market, with FactSet projecting S&P 500 earnings growth of over 17% in 2026, which would mark an acceleration from last year. The critical question for the stock market is whether the propitious estimates will survive a lingering energy shock. Forward price-to-earnings ratios have come down from 22.0x at the end of last year to about 20.0x now, moving closer to historical averages. This is constructive on the margin, as it reflects some of the excess being wrung out of valuations. On monetary policy, while the Fed faces a complicated inflation picture and a leadership transition in the second quarter, we do not expect interest rate hikes in 2026. We think the most likely path remains a hold through the summer with a possible rate cut later in the year, which in a vacuum is neutral to supportive for equities. We see opportunities in companies with pricing power and durable earnings growth, particularly those tied to secular themes. But we are watchful, as the market is likely to continue to trade on geopolitical headlines rather than fundamentals in the near term. Selectivity and patience are essential in this environment.

International Economies and Stock Markets: Energy Dependence Exposed

The Iran conflict has complicated the positive thesis for international economies and stock markets considerably. The core issue is energy dependence. Deutsche Bank estimates that Asia-Pacific countries take 86% of Persian Gulf crude exports excluding Iran. Europe is heavily exposed to natural gas disruptions. India is also quite vulnerable, as fuel costs weigh on household budgets. Surging commodity prices in these key areas provide sufficient cause to reduce growth expectations in most international economies. The exception is China. With a diversified energy mix and large strategic oil reserves, China is better insulated than most. In addition, they have been battling deflation, so the inflationary nature of the current macro environment may be helpful in this regard. Overall, the constructive case for international equities has eroded somewhat due to the Iran conflict. The US, as a net energy exporter, is relatively better positioned to absorb this shock than most, and the dollar has strengthened since the beginning of March. We are not abandoning international exposure, but we recognize that the valuation and policy tailwinds that drove 2025’s outperformance are now offset by a material headwind from geopolitical uncertainty and supply shocks. On the other hand, a swift resolution to the conflict would provide an outsized benefit to international stocks.

Bonds: Orderly Repricing

Bond yields have risen in response to the changing circumstances of the first quarter, but the moves have been orderly and well within the ranges of the past year. The 10-year Treasury yield dipped to 3.96% before the Iran strikes and spiked to 4.48% before closing the quarter at 4.32%. Corporate spreads have widened modestly, indicating greater default risk in certain sectors, though levels remain far from distressed. The bond market operates under a structural constraint worth noting. The US federal debt load continues to grow, with interest costs consuming an increasing share of the federal budget. That limits the flexibility of policymakers compared to prior cycles and has placed the 10-year Treasury yield range solidly higher than it was in the low-interest-rate era of 2009 - 2020. This is not a crisis today, but it narrows the margin for policy error over time and is a factor investors should weigh when making duration decisions. We continue to favor high-quality, short-to-medium maturity bonds where investors can earn attractive income without taking on unnecessary duration or credit risk.